In these days of streamlining, rightsizing and re-engineering, opportunities emerge to bring "independent contract labor" into the company. It's a productivity tool in terms of hiring exactly what a business needs, when it's needed, for only as long as it's needed. Independent contract labor also spares a company from reporting requirements, payroll and other taxes that are associated with "employees."

The trick is an awareness of what does and doesn't classify employees as independent contractors. Historically one of the biggest headaches confronting small business owners and the subject of endless litigation, classification of independent contractors may finally get some resolution. The IRS is clarifying guidelines, beefing up training of its field auditors and implementing new procedures for resolving contractor-versus-employee issues earlier in the audit process.

Currently, the IRS uses a complex set of 20 common-law factors when determining contract-employee status. Failure to meet these criteria constitutes grounds for the worker to be reclassified as an employee and for the company to pay retroactive Social Security and income taxes it should have withheld.

New training materials for IRS auditors emphasize the degree of control the business exercises over the worker as the determining factor. If an employer has the legal right to control what is done and how it's done, the worker is an "employee."

At the same time, the IRS initiated a two-year trial period of a Classification Settlement Program, which focuses on future compliance rather than concentrating heavily on punishment for past noncompliance. Businesses can qualify for CSP by filing appropriate returns for workers in question and agreeing to classify such workers as employees in subsequent years. A qualifying business could pay as little as 25 percent of one year's back taxes and thereby avoid litigation costs. Although not a solution for every company, this program is a first step toward settlement.

Despite the IRS's efforts, it's still difficult for most businesses to establish independent-contractor status. It's best to consider independent-contractor classification the exception rather than the rule. If your company uses temporary employees contracted through an employment agency, ask the agency about its policies regarding collection and payment of payroll taxes.

Published in DBA Houston, September 1996

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